United States: Why Does Our Legal Function Cost So Much?

Last Updated: June 1 2011
Article by Carl Krasik

This is the sixth in a series of Client Alerts on thorny issues faced by General Counsel and Corporate Secretaries. Previous Alerts have focused on issues in the context of Board and Committee meetings such as when a matter needs to be taken to the Board, the length and scope of Board and Committee minutes, Directors' use of corporate or charter aircraft to attend meetings, who should be in the meeting room, and words and phrases to avoid when making a presentation. This Alert deals with management of the Legal Department and the issues a General Counsel faces when the Chief Executive Officer or Chief Financial Officer asks:

Why Does Our Legal Function Cost So Much?

Few issues create heartburn for the General Counsel as does being challenged to justify the expense of the organization's legal function. The issue may arise in the fall in connection with the organization's annual budgeting process, or as a result of a high-profile litigation (most often, following a loss), or in connection with recognizing an unusual increase in the litigation reserve as a charge to quarterly earnings. However the issue may arise, the General Counsel is immediately put on the defensive and begins a frantic mental search for an appropriate response. This Alert discusses some ways a General Counsel might think about the issue and some potential responses.

The first requirement in answering the question of why the organization's legal function is so expensive is knowing what the organization's legal function actually costs. By this, I mean both the all-in cost of the internal legal department plus the outside counsel spend. Not included are payments made to settle or amounts of judgments entered in litigation matters. Presumably, these are charged to the applicable business line. Different organizations will account for the expense of the internal legal department differently, but whatever accounting approach the organization uses, it is critical that the General Counsel have at his or her fingertips a single number that represents his or her best estimate of the annual cost of the internal legal function. This includes the cost of the legal function at all subsidiaries and at all operations around the world, and all indirect expenses such as employee benefits, imputed office rental charges, travel and entertainment, library services, etc. One cannot begin to justify the expense of the organization's legal function without first knowing the annual cost of the internal legal function. If the General Counsel has to say to the CEO or CFO, "I'll get that number and be back to you," he or she is immediately on the defensive. That number should be at his or her fingertips.

The external legal spend should, at least in theory, be an easier number to obtain. Again, it doesn't matter if the external legal spend is budgeted to the legal department or to lines of business and control functions (e.g., HR). The General Counsel should have at his or her fingertips both the annual budgeted amount for the current year and a good estimate of the actual spend to date. Two factors can make these numbers a bit tricky. The first is the vagaries of the litigation process and the aggressiveness of the opposing side. The second is the presence of contingent "alternative fee arrangements" that can produce higher or lower actual payments, depending on the outcome of a matter. The best a General Counsel can do here is make a most-likely case estimate of what the fees will be. And of course, part of justifying the organization's legal expense is being able to say to the CEO and CFO that the General Counsel has negotiated fee arrangements with law firms and other vendors (whether traditional or alternative) that deliver maximum value for the dollar.

One factor that will likely impact the cost of the legal function is the ratio of outside counsel/ inside counsel spend. This is a complex subject that will likely be the subject of its own Client Alert, but the accepted wisdom is that an organization saves money by bringing more work in-house. I would not argue with the accepted wisdom to the extent that one is measuring incremental cost for a given unit of work, but I would only suggest that the presence of additional inside counsel leads to increased use of outside counsel as more issues are identified and dealt with. I would argue that this is to the long-term benefit of the organization but at a short-term cost.

External factors will significantly impact the absolute cost of the legal function. Large organizations will spend more than smaller ones. International operations, large numbers of employees, multiple lines of business, being in a regulated industry and being subject to new and complex regulations, will also add to costs. One way to neutralize, at least in part, the impact of these variables is to express the cost of the legal function in terms of pennies per dollar of revenue. That is, it is useful to be able to say that for every dollar of the organization's revenue, one cent or two cents (or whatever the actual number is) of every revenue dollar is required to support the organization's legal function. This permits (in a pie chart sense) the legal expense to be compared with the cost of other of the organization's functions.

Inevitably, the CEO or CFO will ask at some point whether "our" legal function costs more or less than that of our peers. Expressing costs in terms of pennies per dollar of revenue helps in doing this comparison. The problems here, however, are two. First, there is an issue with finding true peers. If publicly traded, the organization will have identified peers it uses for HR and total shareholder return-performance graph purposes, but somehow there are always some significant differences among these peer companies. Second, even after peers have been identified, there is a question of whether one is getting comparable numbers for one's peers. By definition, you know how your numbers have been computed, but you don't know whether the comparison with peers is "apples to apples." If the organization's costs are lower than those of its peers, the General Counsel now has an easy answer for the CEO or CFO, although I would suggest this result might lead to some introspection as to whether the organization may be a bit underlawyered. It seems that more frequently, however, the organization's numbers are higher than its peers. As a result, the General Counsel may feel somewhat at a loss as to how to explain this difference to the CEO and CFO because he or she honestly believes that a lower level of lawyering would represent unacceptable risk to the organization.

At this point, the analysis moves from the objective to the subjective. One of the most important functions performed by the General Counsel is translating the risk tolerance of the organization as defined by the CEO and the Board to the real-world operation of the Legal Department. If the organization has defined for itself a lower risk tolerance (or if, for example, in a regulated industry, the organization has had a lower risk tolerance defined for it by its regulator(s)), it will require more lawyering (whether internal or external) to achieve that goal. Part of the General Counsel's answer to the CEO and CFO as to why its legal function costs what it does is that it reflects progress toward achievement of the broader organization goal of risk reduction. Second, I think a safe assumption is that all General Counsel have as a primary goal the delivery to the organization of true substantive value and outstanding client service. Achievement of that goal requires high-quality, dedicated and engaged internal counsel, and top-quality outside counsel, and, in short, that "doesn't come cheap." If the General Counsel has been successful and over the years the Legal Department has earned a reputation for delivering value and excellent client service, the CEO and CFO are quite likely to be tolerant of a numbers gap with peer organizations. If not, they are more likely to focus just on the numbers.

The answer to why an organization's legal function "costs so much" is a combination of objective and subjective factors. In addition to the importance of monitoring the internal and external spend numbers on a continuing basis, a General Counsel can feel confident that his or her focus on outstanding client service and delivering value to the organization will pay significant dividends if and when the cost of the legal function is challenged.

This article is presented for informational purposes only and is not intended to constitute legal advice.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions